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By Stephenie Overman

Companies with employees in Latin America are adapting to the privatization of pension systems throughout the region. Among the latest systems to join the ranks is that of the United States’ next door neighbor, Mexico.

In September the first $400 million of employee savings and matching employer contributions began flowing to private money managers instead of to the Mexican government’s pension system.

More than 8 million Mexicans — 73% of those eligible — signed up to take their pension money out of the nearly bankrupt social security system and put it into private funds called AFORES. In Spanish, AFORES is an acronym for retirement fund administrators (administradores de fondos para el retiro).

Under the old system, the total contribution for social security was 15.5% of total payroll; employers paid 12.95%. Under the new system the contribution will average 17.5% of total payroll but employers’ contribution remains the same. Employees will contribute 2.1% to 5% and a new “social contribution” made by the government will make up the rest.

Pattern established

Privatization of pensions is nothing new in Latin America. In 1981, Chile set up a system of private retirement accounts funded by mandatory contributions from employees in the form of payroll deductions. These are run by tightly regulated private retirement plan administrators.

About 5 million workers participate in Chile’s private system, with 3.2 million making regular contributions.

Peru, Argentina, Colombia and Uruguay have adopted pension reform similar to Chile’s. Bolivia and El Salvador join Mexico in this year. Venezuela is expected to privatize its system next year and other Latin American countries are discussing the move as well.

The Mexican Social Security Institute (IMSS) historically has provided health insurance, death and disability coverage and pensions to nearly all Mexican workers through quotas drawn directly from paychecks.

Toward the end of the 1980s, the quality of government-provided medical services dropped and those who could afford private health care increasingly left the public system. At the same time, the pension system was headed for bankruptcy.

Seventeen AFORES have been set up to handle the pension funds. These must have majority ownership by Mexican companies, although they are open for foreign participation. Because of NAFTA, U.S. and Canadian companies can wholly own an AFORES. U.S. companies such as Aetna, Citibank, GE Capital, Bank of Boston and American International Group are among the foreign companies that own pieces of AFORES.

For U.S. insurance companies, private pension fund management in Latin American complements other lines of business, ranging from short-term health and casualty policies to life insurance and annuities, which many of the pension accounts now being formed will someday convert to.

Mexico is also working toward widespread privatization of health insurance and a flexible workplace liability system that would offer rewards for good safety records.

Privatization “has worked very well in Chile,” according to Jacobo Rodriguez, assistant director of the program on global economic liberty at the Cato Institute, a libertarian public policy research organization based in Washington. D.C.

“The tax on labor — that’s what social security amounts to — has been removed. It has promoted employment. Workers and employers benefit,” he said. Chile has an unemployment rate of about 5.5%, which “for an emerging economy is phenomenal,” Rodriguez says.

The private pension system also has made available “a pool of internal capital through which employers have been able to grow. The Chilean economy is not so dependent on foreign capital,” according to Rodriguez. During the Mexican peso crisis, “Chile was not as affected as other economies in the region. It was able to draw on the pool of internally generated savings.”

Rodriguez is concerned about administrative differences between the Mexican system and the Chilean system. In Mexico contributions will be sent to the social security administration, which send the contributions on to a pension administration company of the employee’s choice. In Chile the money goes directly to the pension administration company, which then deposits it in the account of the worker.

“In Chile, it is direct. In Mexico, there is another layer of bureaucracy and some way the money can always get lost. In Mexico that’s happened many times before,” he says.

Also, one of the 17 AFORES is publicly owned by the social security system. “It will have a problem playing the role of clearinghouse when it is one of the market participants,” he predicts.

But Rodriguez sees other administrative differences as improvements. In Mexico AFORES are not required by law, as they are in Chile, to guarantee a minimum rate of return and are allowed to manage more than one fund. In Chile, they can manage only one fund.

“This reduces administrative costs and removes incentives for workers to switch back and forth between AFORES. It allows AFORES to offer funds with different combinations of risk and return,” he explains.